Tuesday, November 10, 2009

The Market's Not That Complicated

The markets continue to frustrate most investors as trends that have been in place for much of the year remain operative long after most of the experts believed they had already gone way too far.

Most pundits have been advising caution for months as world stock markets continue to march higher. They have been declaring buy-and-hold strategies to be long dead in this new age of high-speed trading strategies and risk management.

The new way of thinking is perhaps best showcased on CNBC’s Fast Money—a daily one-hour program where the underlying assumption is that intelligent trading and investment strategies change every minute and the only way to make money in this complex world is to shorten one’s time horizon accordingly.

I couldn’t disagree more.

There are new developments on a daily basis that do affect the prospects for specific industries and companies and one does need to pay attention to the news. But the trends that have been driving the markets this year are macro and secular and should be with us for a long time to come.

Here are the four themes that have driven and continue to frame my investment approach:

1. The U.S. and other countries that were devastated by the financial meltdown last year have responded by printing mountains of paper money that is backed by no tax revenues or assets in an effort to stimulate their economies and avoid what would have been a systemic collapse.

As a result, it is taking more and more of those pieces of paper to buy real stuff—hard assets like gold, copper, energy, and other basic materials. The pundits keep talking about the falling value of the dollar but it goes beyond that. We are in the early stages of a period where the currencies of many countries should be viewed with suspicion as the weak economy and low tax rates continue to reduce tax revenues as the printing presses around the world continue to crank out more and more pieces of paper money.

This is not a trend that is likely to change in the foreseeable future.

2. The U.S. has developed a culture of entitlement and our demographics make us far less attractive to investors than many other markets.

I am part of the problem. I’m a baby boomer who will be a productive, tax-paying worker for several more years but for most of the rest of my life—which will hopefully be several decades—I will become an expensive national liability consuming social security, Medicare, and other entitlement dollars.

I am not alone. It seems that countries like Brazil, India, Taiwan, China, Korea, Australia and other nations where the average age and national and personal debt levels are much lower are better positioned for growth going forward.

Fortunately, it has never been easier for investors to buy into specific geographies and industry sectors as part of a portfolio strategy than it is today.

3. There is an apparent disconnect between the U.S. economy and the stock market. The market has advanced for eight straight months and hundreds of companies are reporting excellent earnings even as unemployment has risen into double digits and many people remain deeply in debt.

There are actually two trends at work here, neither of which is likely to change in the near term.

First, most companies have eliminated lots of jobs and have cut other costs dramatically. They are more focused than ever on getting more work and productivity out of the employees that remain. From an investment perspective, this trend has helped the business of technology companies and others who provide products and services that enhance productivity and make operations more efficient.

The second trend relates to the weakness of the dollar. Those U.S. companies that do most of their payroll and manufacturing spending in dollars but derive most of their revenues from overseas are doing very well in this environment and are likely to continue to benefit going forward.

4. Interest rates on U.S. Treasuries and government guaranteed deposits have been kept artificially low by federal authorities who are trying to keep the cost of funds to the banks at rock-bottom levels and create the illusion that there is still solid demand for our nation’s debt.

I believe this has created a ticking time bomb for conservative investors who remain heavily invested in cash equivalents and government bonds. At some point, inflation and higher interest rates will have to kick in and when that happens, investors who have sought safety will find that they had the same number of dollars as they did before but those dollars may buy far less goods and services than they used to.

We continue to monitor the economy and the markets carefully and I will keep you posted regarding the situation going forward.

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